• RIGH T OFF THE BAT, 2018 saw the widest
range of the CBOE Volatility Index (VIX)
since 2015—from a low of 8.92 at the start of
the year, to a high of 50.3 in early February.

That’s almost a 500% change in about a
month. Is there something going on in the
market? Or is the VIX overly sensitive?

Consider this a cautionary tale about
how you may trade the VIX. The risk in the
VIX tends to be asymmetrical. When it’s
low (low teens), the risk tends to be on the
upside, historically. The VIX can go lower.

But unlike a stock that can go to zero, the
VIX could go to zero only if global finance
discovers there’s no more uncertainty in
the market. Could that happen? In theory,
yes. But in practice, the VIX at 12, for example, is generally less likely to drop by half its
value than it is to double in value.

That’s why shorting the VIX can be risky.

Just as the market may crash faster and further than it can rally, the VIX, which tends
to move in the opposite direction of the
stock market, can have large increases in a
short time frame. So, if you believe the VIX
might drop, and you decide to short it, you
may want to consider defined-risk strategies. And keeping your position size small.

It’s all about uncertainty

The VIX makes these moves in part because its calculation uses the average of
SPX options’ bid and ask prices, and not
executed options trades. When market
makers change their bid and ask prices to
respond to the risk perception in the SPX,
the VIX changes, too. And as bid and ask
prices can change in milliseconds, the VIX
can change almost as fast.

For example, if an SPX option is 0.40 bid
and 0.70 ask, the 0.55 average price is used
in the VIX calculation. Yet, if an economic
number is scheduled to come out, or there’s
some news that spooks SPX market makers,
that option’s bid/ask might widen to 0.40
bid and 0.80 ask without a change in the
SPX price. The market maker widens out